Money and Banking Flashcards
(31 cards)
Define Money
An item which is generally acceptable as a means of payment
What are the Functions of Money
- Medium of Exchange
- Store of Value
- Measure of Value
- Standard of Deferred Payment
What are the 6 characteristics of money?
- Acceptable
- Portable
- Divisible
- Durable
- Diffiuclt to Forge
- Limited in Supply
What is the problem with the Barter System?
It requires a double coincidence of wants
What is Narrow Money? [M0]
Money that can be spent directly i.e notes and coins, deposits [highly liquid]
What is Broad Money? [M4]
Non-cash financial assets that can be converted into cash i.e bonds, certificates of deposits
What is the Quantity Theory of Money?
A direct link between money supply and inflation
Inflation is always and everywhere a monetary phenomenen-Milton Friedman
What is the Fisher Equation?
MV = PQ
What do the variables in the Equation Stand for?
M : Money Supply
Velocity : Velocity of Circulation [the number of times a given amt of money is changing hands in an economy in a year]
P : Average Price Level [Inflation]
Q : Real GDP
What are the variables that influence prices in the economy
P = MV/Q
What is the Monetarist Argument in this Theory?
It is only the money supply that influences prices- because V and Q is fixed.
V may change in a recession or boom, however, it will not be enough to influence prices
overtime, Q may be relatively constant - Real GDP in the UK has been around 2 to 2.5% since the 1970s, there may be deviations, but not enough to influence prices
Conclusion: M = P
Why is the conclusion of M = P?
More money chasing the same quantity of goods means prices will rise to compensate it
What is the Keynesians Debate on the Theory?
V may not be fixed as it can decrease significantly which results in a non-direct link, for example, in a recession, the money supply can increase, but there may be a liquidity trap which reduces the velocity of circulation [number of transactions taking place]
What are the objectives of a commercial bank?
- Profitability
- Liquidity
- Security
Explain Profitability
- Borrow short term
- Lending long term
- Taking more risk [offering non-secured loans] - charge higher interest
Explain Liquidity and Security
Holding more cash and reserves ensures liquidity to prevent risks of bank failure
Security is required to manage risks and avoid insolvency
These sacrifice some profits but prevents the risk of systemic risk, lost incomes, jobs and recession pressure
What is the Reserve Ratio?
The fraction of deposits a commerical bank holds in reserves
Explain Credit Creation
An increase in bank deposits increase money supply because:
1. a rise in deposits increase the banks reserve, which is the amount of money that can be lent out
2. every dollar of the newly available money lent out will further add to the money supply, creating a ongoing process of credit creation
Explain the Money Multiplier
Borrows expenditure on goods and services will eventually work their way back into the backing system as additional deposits, which will further increase the banks reserves and ability of credit creation
The smaller the required reserve ratio, larger the money multiplier as banks can lend a larger percentage of deposits
Define Quantitative Easing
Large scale open market purchases of government bills/bonds by the central bank in order to increase the money supply and influence aggregate demand and growth
Explain how Quantitative Easing Works
Open Market Operations
The central bank purchases these assets [bills/bonds], usually held by commerical banks in highly illiquid forms. This increases their excess reserves which allows them to increase loans, increasing money supply through the money multiplier
What is the Liquidity Preference Theory?
A keynesian concept that explains why people demand money. It includes the precautionary motive, speculative motive and transactions motive.
Explain the transactions motive
It is the desire to hold money for everday expenditure and payment obligations. It is autonomous of interest rates as the amount held by households/firms is influenced by the income recieved and frequency of payments.
Demand for money may rise with income as households may want to spend more.
Explain the precautionary motive
A reason for holding money for unexpected or unforseen events. The precautionary motive may increase as incomes increase, as consumers may want to put aside more money for unforseen events, which increases the demand for money. This is also interest inelastic, which means firms may not significantly cut back on their transactions or precautionary motive if interest rates are high.
